THEORETICAL  DEPRECIATION 

A  menace  to  the  public  and  the  investor 


by 

George  N.  Webster 

New  York 


try 


THEORETICAL   DEPRECIATION 
A  menace  to  the  public  and  the  invest<Mr 

The  most  serious  menace  to  which  investors  in  the 
securities  of  pnbKc  service  corporations  are  exposed 
to-day  results  from  their  failure  to  comprehend  and  to 
combat  unsound  and  destructive  theories  of  valuation, 
which,  when  employed  in  the  determination  of  the  value 
of  their  properties  for  purposes  of  rate  regulation,  op- 
erate to  confiscate  a  very  substantial  percentage  of  their 
investment. 

The  term  "confiscate"  is  used  advisedly.  If  an  in- 
vestor has  expended,  for  example,  $100,000  in  plant  and 
equipment  devoted  to  the  public  service  and  has  rendered 
service  therewith  for  a  number  of  years  at  legal  rates, 
yielding  a  legitimate  return  upon  his  investment  and 
nothing  more,  and  has  collected  from  his  patrons  nothing 
representing  a  return  to  him  of  his  investment  or  any 
part  of  it,  and  if  his  property  is  then  appraised  and,  as 
the  result  of  the  method  employed,  is  found  to  have  a  pres- 
ent value  of  say  $70,000  and  the  rates  he  is  permitted 
to  charge  are  adjusted  so  as  to  yield  a  return  on  only 
$70,000,  then  his  investment,  to  the  extent  of  $30,000,  has 
been  confiscated. 

When  it  is  considered  to  what  extent  owners  of  prop- 
erty are  protected  by  federal  and  state  constitutions, 
federal,  state  and 'municipal  laws,  municipal  and  police 
regulation  and  a  vast  legal  machinery,  against  the  con- 
fiscation, expropriation,  seizure  or  theft  of  their  prop- 
erty and  by  what  simple  means  these  agencies  of  protec- 
tion may  be  invoked  in  behalf  of  the  individual  or  cor- 
poration, it  is  amazing  to  observe  the  extent  to  which 
property  is  confiscated  under  the  guise  of  rate  regula- 
tion, with  hardly  a  protest  being  raised  by  the  victims. 
They  are  bewildered  by  reiterated  protestations  that  jus- 


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tice  must  be  done  to  investors,  in  the  very  opinions  which 
destroy,  in  part,  their  investments. 

Furthermore,  when  it  is  considered  that  the  adoption 
of  these  methods  has  already  resulted  in  the  confiscation 
of  hundreds  of  millions  of  dollars  invested  in  public 
utility  properties,  and  that  its  general  adoption  would 
result  in  the  confiscation  of  several  billions  more,  it  would 
appear  as  though  it  were  high  time  for  those  whose  inter- 
ests are  thus  threatened  to  bestir  themselves  in  defense 
of  their  properties  and  for  those  who  are  clothed  with 
authority  and  power  to  determine  rate  cases,  involving 
a  consideration  of  the  element  of  property,  to  inform 
their  minds  as  to  the  fundamental  economic  facts,  which 
are  of  paramount  importance  and  which  must  be  given 
controlling  consideration  if  the  interests  of  the  public 
and  of  the  investors  are  to  be  conserved. 

No  one  will  dispute  the  fact  that  the  interests  of  the 
investor  and  of  the  public  are  so  interwoven  and  inter- 
dependent that  neither  can  be  advantaged  at  the  expense 
of  the  other,  nor  exploited  for  the  benefit  of  the  other; 
that  each  must  share  in  the  other's  prosperity  or  adver- 
sity and  that  they  who  hold  to  the  contrary  and  whose 
activities  disregard  this  fundamental  fact  are  either 
short-sighted  mischief-makers  or  demagogues. 

Not  a  little  of  the  pernicious  activity  which,  for  the 
past  ten  or  fifteen  years,  through  drastic  rate  regulation 
based  on  false  theories  of  valuation,  has  been  sapping 
the  vitality  of  our  public  service  companies  and  paralyz- 
ing their  efficiency,  may  be  attributed  to  German  propa- 
ganda, the  mouthpieces  of  which  have  included  certain 
politico-scientific  periodicals,  of  supposed  respectability 
and  patriotism,  at  leiast  one  of  which  eliminated  evidence 
of  its  German  connections  in  Berlin  from  its  title  page, 
only  when  we  declared  war  upon  Germany. 

The  method  of  unsound  valuation  against  which  this 
article  is  directed  may  be  described  briefly  as  the  "cost 
less  depreciation"  method.  The  "cost"  may  be  ** original 
cost,  * '  *  *  average  cost  * '  or  *  *  present  cost. '  *    The  deprecior- 


Hon  which  is  deducted  therefrom  and  which  may  be  said 
to  have  its  origin  in  the  concept  that  used  property  is  less 
valuable  than  new  property,  is  based  upon  the  assump- 
tion that  used  property  becomes  uniformly  less  valuable 
during  the  period  of  its  alleged  life  expectancy,  starting 
at  one  hundred  per  cent,  value  and  ultimately  reaching 
zero  value.  The  amount  to  be  deducted  is  computed  by 
finding  the  ratio  of  the  expired  life  to  the  assumed  total 
life  and  by  applying  that  ratio  to  the  "cost" ;  the  amount 
thus  obtained,  deducted  from  ''cost,"  is  supposed  to 
represent  the  ** present  value." 

The  advocates  of  the  depreciation  theory  would  state 
the  formula  in  this  way:  A  unit  of  equipment  costs 
$10,000;  it  had  a  life  expectancy  when  installed  of  thirty 
years;  ten  years  have  elapsed;  ten  years  is  one-third  of 
thirty  years;  one-third  of  $10,000  is  $3,333.33;  this  de- 
ducted from  the  **cost"  leaves  the  ''present  value"  of  the 
unit  of  equipment  as  $6,666.67. 

It  is  not  conceivable  that  any  one  could  give  the  sub- 
ject of  depreciation  of  the  kind  here  illustrated  serious 
consideration  without  discovering  its  utter  fallacy.  That 
so  few  have  raised  their  voices  in  protest  against  it  must 
be  attributed  to  the  fact  that  few  have  really  considered 
it  seriously.  These,  who  are  unalterably  opposed  to  the 
theory,  include  some  economists,  some  members  of  the 
judiciary,  a  few  of  the  Public  Service  Commissions,  some 
executives  of  corporations  and  some  members  of  the 
legal,  engineering  and  accounting  fraternities.  They 
have  discovered  thdt  the  question  is  not  one  of  engineer- 
ing, nor  of  accounting,  but  one  of  economics  and  finance 
and  the  legal  protection  of  property  rights. 

There  are  many  engineers  of  honest  intention  who  ]    i^..v^  -i) 
pretend,  or  even  think,  they  have  knowledge  of  this  [  i     ^ 

subject,  who  while  competent  in  the  ordinary  branches         '  *^ 
of  construction  engineering  are  utterly  lacking  in  a  real 
and  fundamental  understanding  of  this  dangerous  fal- 
lacy of  "theoretical  depreciation." 


The  problem  is,  in  fact,  not  one  of  engineering  nor 
is  it  one  that  engineering  training  fits  an  engineer  to 
properly  understand.  The  same  may  be  said  of  the  ac- 
countant and  his  training.  The  subject  is  one  primarily 
of  applied  economics  and  must  be  studied  from  the  stand- 
point of  the  mutual  economic  interests  of  the  consumer, 
and  the  investor. 

There  is  much  to  learn  and  many  pitfalls  of  false 
logic  and  misleading  partial  reasoning  to  be  avoided  and 
combated.  So  far  as  the  honest  engineer  and  accountant 
is  concerned,  in  great  part  his  countenance  of  the  error 
has  resulted  from  his  assumption  that  the  problems  in- 
volved are  simple  and  through  his  acceptance  of  the 
superficial  conclusions  of  specious  presentations. 

Those  who  advocate  it  as  a  business — the  professional 
depredationists — are  in  a  class  by  themselves.  We  will 
speak  of  them  later. 

The  most  sinister  support  which  the  depreciation  theory 
receives  may  be  traced  to  socialistic  propaganda.  Conced- 
edly,  the  ultimate  goal  of  socialism  is  state  ownership  of 
all  instrumentalities  of  industry.  The  immediate  objec- 
tive is  state  ownership  of  all  public  utilities,  or  state  oper- 
ation without  ownership.  The  so-called  "progressives" 
in  the  Eepublican  and  Democratic  parties  co-operate  with 
the  socialists  in  the  attack  on  the  immediate  objective. 
The  socialists  cannot  expect  to  attain  their  ultimate  object 
of  state  ownership,  or  state  operation  without  ownership, 
of  all  industries  and  all  property  until  they  have  first 
brought  under  federal,  state  or  municipal  ownership  or 
operation  all  of  the  public  utilities.  For  the  accomplish- 
ment of  the  latter,  they  have  a  perfectly  definite,  settled 
program,  viz.:  the  strangulation  of  public  service  com- 
panies through  rate  regulation,  service  regulation  and 
taxation,  to  the  point  where  the  companies  themselves 
will  seek  relief,  in  public  ownership,  from  absolute  bank- 
ruptcy and  accept  almost  anything  they  can  get  for  their 
properties.  One  means  to  this  end  is  to  insist  on  fran- 
chise requirements  adapted  to  periods  of  lower  prices,  as 


in  the  case  of  the  street  railways.  An  equally  eflScacious 
operation  is  to  exploit  the  theory  of  depreciation  as  a 
means  of  reducing  value  of  public  service  properties  to  a 
bargain  basis.  That  the  application  of  the  theory  in  any 
particular  instance  results  in  immediate  partial  confisca- 
tion is  what  commends  it  to  them.  They  would  confiscate 
all  of  the  property  if  they  could  do  so.  As  this  class, 
however,  constitutes  but  a  negligible  minority,  it  may  be 
assumed  that  its  activities  will  not  long  delay  the  uni- 
versal recognition  of  fundamentally  and  economically 
sound  principles  in  rate  regulation.  There  are  unmistak- 
able signs  that  the  country  is  exasperated  by  radicalism. 

Those  who  have  been  impressed  by  the  theory  have 
been  beguiled  by  false  analogies.  They  have  been  led  to 
liken  a  railroad  system,  representing  an  investment  of 
millions  of  dollars  and  composed  of  a  myriad  of  units  of 
plant  and  equipment,  to  an  article  of  furniture,  a  suit  of 
clothes  or  some  other  familiar  object,  and  to  believe  that 
as  the  used  table  has  lost  some  of  its  value  so  the  used 
railroad  has  lost  some  of  its  value;  that  railroad-fares 
should  be  based  upon  'Walue"  so  conceived  and  that  a 
used  railroad  should  charge  a  lower  fare  than  a  new  rail- 
road. The  fact  that  the  analogy,  however  plausible,  is 
fallacious  to  the  point  of  absurdity  has  eluded  their 
understanding. 

The  analogy  is  false  because  it  assumes,  in  respect  of 
an  instrument  employed  in  producing  a  service,  that  its 
age  affects  the  value  of  the  service  rendered  and  the  price 
which  should  be  charged  therefor.  The  falsity  of  the 
assumption  becomes  at  once  apparent  when  it  is  consid- 
ered that  the  individual,  as  the  possessor  of  a  chair  and 
table,  and  the  railroad  company  as  the  possessor  of  rail- 
road plant  and  equipment,  are,  in  a  sense,  in  the  same 
position  in  regard  to  their  respective  properties.  In  both 
cases,  the  properties,  by  performing  their  respective  func- 
tions, enable  their  owners  to  render  service.  The  func- 
tioning, under  the  direction  of  the  railroad  company,  of 
the  railroad  plant  and  equipment,  enables  the  company 


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to  supply  a  railroad  service.  The  functioning  of  the  chair 
and  table,  as  office  furniture,  enables  the  individual  to 
render  service  to  his  clients.  He  can  transact  just  as 
much  and  just  as  important  business  at  an  old  desk  as  a 
new  one ;  the  age  of  the  chair  he  sits  on  is  no  criterion  of 
his  service  efficiency  nor  of  the  value  of  the  service  he 
renders;  not  being  a  furniture  dealer,  the  comparative 
value  new  and  second-hand,  of  his  office  furniture,  enters 
not  at  all  into  the  determination  of  any  of  his  business 
transactions,  nor  of  the  amount  of  the  bills  he  renders 
for  his  services ;  and  nevertheless  he  accepts,  offhand,  the 
proposition  that  the  railroad-fare  he  pays  should  be  de- 
pendent, in  a  measure,  upon  the  age  of  the  upholstery  of 
his  seat  in  the  train,  even  though  he  may  be  unable  to 
detect  from  any  visual  examination  whether  it  is  one  year 
old  or  ten. 

When  the  services  of  a  professional  depredator  are 
retained  by  a  municipality,  it  is  in  order  that  by  the 
exploitation  of  his  theory  of  depreciation  a  reduction  in 
rates  may  be  effected,  not  because  the  service  has  in  any 
way  deteriorated  but  solely  because  the  plant  and  equip- 
ment employed  in  rendering  it,  while  in  every  way  as 
good  as  new  and  functioning  just  exactly  as  well  and 
possibly  infinitely  better  than  when  it  was  new,  is  de  facto 
not  brand  new. 

The  professional  depredator  refers  to  the  plant  and 
equipment  as  second-hand  and  disingenuously  inquires  if 
second-hand  plant  and  equipment  is  worth  as  much  as  new 
plant  and  equipment.  The  answer  is  decidedly  yes.  Di- 
vorced from  its  earning  capacity,  a  new  plant  would  be 
only  a  heap  of  junk.  Coupled  with  an  earning  capacity 
based  upon  the  recognition  of  sound  economics,  justice 
and  common  sense,  the  second-hand  plant  and  equipment, 
in  operation,  is  worth  substantially  more  than  a  corre- 
sponding amount  of  new  plant  and  equipment.  Aside 
from  the  advantage  of  having  a  market  for  its  product 
and  an  established  business,  such  a  plant  has  "found 


itself,*'  all  the  kinks  have  been  ironed  out,  the  plant 
organization  has  been  perfected,  and  it  is  working  a  great 
deal  more  efficiently  and  economically  than  a  new  plant 
could  possibly  work. 

In  substance,  the  professional  depredator  assigns  to 
the  various  units  of  plant  and  equipment  a  second-hand 
value  and  then  blandly  asks  if  the  value  of  the  whole  can 
be  greater  than  the  sum  of  the  parts.  This  specious  prop- 
osition disregards  the  obvious  facts,  (1)  that  the  invest- 
ment of  the  owners  is  in  the  plant  as  a  whole,  (2)  that  the 
investment  is  not  made  for  the  purpose  of  creating  a 
museum  of  second-hand  plant  and  equipment  but  because 
it  has  to  he  made  in  order  that  the  investors  may  render  a 
perpetual  service  in  accordance  with  their  franchise,  (3) 
that  the  investment  remains  intact  until  it  has  been  repaid 
in  part  or  in  whole  and  (4)  that  there  has  never  been  any 
contract  or  agreement  between  investors  and  their  pa^ 
trons  for  the  repayment  of  any  part  of  the  investment 
in  plant  or  equipment  in  service. 

The  modus  operandi  of  the  professional  depredator, 
as  stated,  is  to  guess  at  what  he  terms  the  ''life  ex- 
pectancy" of  the  plant  and  equipment  in  service  and 
having  computed  the  percentage  of  ' '  e^gire^JJilfiL"  he 
uses  the  same  percentage  to  compute  ** expired  value." 
He  does  not  like  to  say  ' '  expired  investment. ' '  He  avoids 
the  use  of  the  word  investment  because  he  knows  it  will 
tangle  him  all  up.  He  does  not  want  to  be  asked  to  ex- 
plain what  he  means  by  expired  investment  or  what  has 
become  of  the  expired  investment;  or  to  explain  how 
an  investment  can  expire.  These  things  embarrass  him. 
He  sticks  to  value,  because  he  knows  that  value  is  an  elu- 
sive and  ambiguous  term  and  that  there  is  less  likelihood 
of  some  one  pinning  him  down  to  admitting  that  he 
doesn't  know  what  it  means,  than  there  is  of  some  one 
pinning  him  down  to  an  admission  that  an  investment 
can  not  expire.  He  knows  nothing  about  accounts  and 
less  about  engineering.  In  order  to  perform,  he  has  to 
have  a  figure  to  start  with.    If,  with  the  help  of  an  ao- 


8 

countant,  lie  can  get  the  original  cost  of  the  property,  he 
uses  that  and  calls  it  "reproduction  cost,"  although  he 
knows  it  is  nothing  of  the  kind.  If  an  engineering  valua- 
tion new  is  presented  to  him  he  wiU  generally  accept  it 
and  call  it  too  ''reproduction  cost."  He  is  not  particu- 
lar. All  he  wants  is  a  principal  sum  on  which  to  use  his 
depreciation  method.  From  either  he  will  deduct  a  per- 
centage corresponding  to  his  guess  as  to  the  percent- 
age of  the  "expired  life"  of  the  property.  He  will,  for 
example,  guess  that  the  life  expectancy  of  the  property 
is  thirty  years.  He  will  guess  that  ten  years  of  the  life 
expectancy  have  expired.  That  equals  thirty-three  and 
one-third  per  cent.  Therefore,  the  present  value  of  the 
property  is  equal  to  the  reproduction  cost  less  thirty-three 
and  one-third  per  cent.  In  order  to  appear  really  scien- 
tific, he  calls  his  present  value  the  rate  base!  Like  a  priest 
of  some  mystic  cult,  he  signifies  the  exclusiveness  of  his 
special  learning  by  the  liberal  use  of  a  new  and  terrify- 
ing terminology  He  displays  weird  mathematical  dia- 
grams, covered  with  wriggling,  portentous  lines  like  a 
robed  sooth-sayer  who  surrounds  himself  in  his  darkened 
chambers  with  the  mummery  of  outlandish  alembics  and 
astronomical  charts.  Thus  these  learned  assassins  of 
values  impose  upon  city  councilmen  and  public  service 
commissioners  and  furnish  a  basis  for  what  they  are  in- 
clined to  believe  or  what  they  deem  it  necessary  to  their 
political  fortunes  to  believe,  and,  gathering  their  fees,  de- 
part. From  the  decisions  of  councilmen  and  commission- 
ers, there  is  an  appeal  to  the  courts  on  the  law,  but  not 
always  on  the  facts.  Value  is  a  matter  of  fact.  The 
courts  are  unanimous  in  holding  that  value,  in  a  rate 
case,  is  not  ' '  exchange  value. ' '  What  kind  of  value  is  it 
then  that  is  not  exchange  value  and  yet  can  be  expressed 
in  doUars  and  cents?  The  best  that  judges  can  do  is  to 
say  that  "value  is  not  a  matter  of  artificial  rules  and 
formulae  but  is  a  matter  of  judgment."  Neither  the 
courts,  nor  the  commissions,  nor  the  alleged  experts  nor 
anybody  else  knows  what  that  value  is,  about  which  they 
talk  so  solemnly. 


.rm 


Even  upon  so  violent  an  assumption  as  that  of  a  man 
who  has  invested  $10,000,  in  a  non-competitive  enterprise 
of  definitely  limited  life  of  say  ten  years,  at  the  expira- 
tion of  which  period  his  plant  and  equipment,  still  in 
perfect  working  order,  must  be  scrapped,  it  could  not 
by  any  process  of  reasoning  be  demonstrated  that  the 
price  charged  for  the  service  rendered  could  be  reduced, 
at  any  time  during  the  period,  because,  forsooth,  his 
plant  was  older  at  the  end  of  the  first  year  than  when  he 
started  and  became  progressively  older  until  it  was 
scrapped.  The  reason  is  obvious.  In  this  case,  which, 
as  will  be  shown,  bears  no  analogy  whatever  to  a  public 
service  company,  if  the  investor  is  to  come  out  whole, 
he  must  collect,  in  his  rates,  in  addition  to  the  cost  of  his 
service,  (1)  interest  on  his  investment,  uniformly,  during 
the  entire  period,  and  (2)  an  annual  sum  which  at  com- 
pound interest  will,  at  the  end  of  ten  years  equal' the 
amount  of  his  investment.  In  the  case  of  a  public  service 
company,  however,  there  is  no  reason  or  justification  for 
thus  amortizing  in  whole  or  in  part  the  investment  in 
plant  and  equipment. 

The  world  is  expanding.  This  country  is  expanding 
more  than  any  other.  There  are  centuries  of  expansion 
before  it.  Then  why  dream  of  amortizing  investment  in 
public  service  companies!  Almost  without  exception 
they  are  growing  not  shrinking.  It  will  be  time  enough 
to  talk  of  amortizing  investments  in  them  when,  if  ever, 
there  are  signs  of  shrinkage. 

The  consideratioUr^f  age  enters  no  more  into  the  ques- 
tion of  the  rates  of  a  public  service  company,  which  is 
able  to  and  does  render  the  service  it  was  organized  to 
render,  than  does  the  age  of  a  taxicah,  or  of  its  driver,  or 
of  the  clothes  he  wears,  enter  into  the  question  of  the 
fare.  A  driver  twenty  years  old  with  a  new  car  and  a 
new  uniform  can  charge  no  more  than  a  man  of  sixty  with 
a  ten-year-old  car  still  operating  efl&ciently.  It  is  trans- 
portation the  passenger  is  buying — and  he  expects  to  pay 


10 

uniformly  for  a  uniform  service,  regardless  of  the  age  of 
the  equipment. 

Nor  does  a  lawyer  or  a  physician  expect  to  regulate 
his  fee  by  the  age  of  his  oflBce  furniture,  as  one  might 
think  he  should  from  the  arguments  of  the  professional 
depreciator.  A  laborer  of  twenty  with  a  new  pair  of 
overalls  draws  the  same  rate  per  diem  as  the  laborer  of 
sixty  with  a  pair  of  womout  overalls.  Both  do  a  uni- 
form day's  work  for  a  uniform  day's  pay  and  age  cuts 
no  figure  so  long  as  uniformity  in  service  capacity  exists. 

A  celebrated  lawyer  who  died  within  a  year  and  who 
bequeathed  many  millions  of  dollars  to  a  great  college 
had  in  his  office  the  simplest  and  oldest  furniture  the 
writer  ever  saw.  Furthermore,  his  earning  capacity  in- 
creased annually  to  the  day  of  his  death  at  the  age  of 
seventy-four.  He  probably  never  realized  what  a  liar  he 
was  making  out  of  the  professional  depreciationist. 

The  fraud  which  would  have  been  perpetrated  upon  the 
public  if  the  theory  of  "depreciation"  which  is  being 
exploited  as  a  profession  by  demagogues  and  impostors, 
had  been  adopted  by  public  service  companies  years  ago, 
when  they  were  starting  in  business,  would  have  been 
on  a  par  with  the  fraud  which  these  charlatans  now  un- 
dertake to  perpetrate  upon  the  companies.  This  would 
be  true  even  if  there  were  such  a  thing  as  life  expectancy 
in  plant  and  equipment.  But  there  is  no  such  thing. 
Aside  from  what  may  be  deemed  to  be  the  wearing  parts 
of  a  complete  system,  including  such  small  units  as  rails, 
ties,  poles,  gas  and  electric  meters,**«tc.,  retirements  of 
units  for  wear  and  tear  do  not  occur.  They  have,  there- 
fore, no  determinable  life.  The  date  when,  if  ever,  they 
will  be  withdrawn  from  service  because  of  obsolescence 
and  inadequacy  cannot  be  even  approximated,  because  the 
date  and  character  of  future  inventions  and  of  the  de- 
velopment of  the  community  cannot  be  foretold. 

The  so-called  "depreciation'*  theory  involves  the 
creation  of  a  useless  reserve.  In  the  case  of  the  Brook- 
lyn Edison  Company  before  the  New  York  Public  Service 


11 

Commission  for  the  First  District,  a  very  thorough  de- 
tailed appraisal  was  made  of  the  Company's  property, 
and  the  Commission's  engineer  demonstrated  that  under 
the  so-called  theory  of  straight  line  depreciation,  the  com- 
pany wonld  acquire  a  depreciation  reserve,  on  a  property 
amounting  to  twenty-four  millions  of  dollars,  of  some- 
thing over  eight  millions  of  dollars,  which  would  never 
be  used  or  useful  to  the  company  or  the  consumer.  The 
methods  and  figures  were  set  forth  clearly  in  the  testi- 
mony in  the  case.  Such  a  reserve  is  construed  by  profes- 
sional depredators  as  evidence  either  of  the  repayment  to 
the  investor  in  the  utility  of  a  part  of  his  investment, 
through  the  medium  of  the  rates  which  he  charges  for  his 
service,  or  of  an  investment  on  the  part  of  the  patron, 
through  the  same  medium,  in  a  part  of  the  plant  and  prop- 
erty employed  by  the  utility  in  the  public  service.  The 
first  theory  would  be  urged  where  the  volume  of  business 
done  by  a  utility  was  stationary ;  and  the  second  would  be 
urged  where  the  growth  of  the  business  involved  addi- 
tional investment  equal  to  or  exceeding  the  amount 
accrued  in  the  so-called  "depreciation  reserve. '* 

Even  where  no  "depreciation  reserve"  whatever  has 
been  created,  the  professional  depredators  argue  that 
one  should  have  been  accumulated  and  that  failure  to  do 
so  is  evidence  that  the  property  has  been  "milked" 
through  excessive  dividends. 

The  fact  that  the  so-called  "accrued  depreciation 
theory"  will  not  stand  the  test  of  application  to  the 
future  is  evidence  that  it  cannot  be  applied  to  the  past. 
It  cannot  be  demonstrated,  for  example,  that  from  the 
standpoint  of  either  the  rate-payer  or  the  company  it 
would  be  a  good  theory  to  impose  upon  the  patrons  of 
the  new  public  service  company.  Thus  considered,  the 
glaring  inconsistencies  of  the  theory  become  at  once 
apparent.  It  can  be  proven  clearly  and  conclusively  that 
a  so-called  "depreciation  reserve"  actually  and  know- 
ingly created  at  the  expense  of  the  public,  by  such  a 
company,  if  such  a  thing  were  possible,  could  not  serve 


12 

any  useful  purpose  either  to  the  company  which  collected 
it  or  to  the  rate-payer  who  paid  it  in  addition  to  the 
actual  cost  of  the  service  he  received.  It  would  be  of  no 
advantage  to  the  company,  because  (among  other 
reasons)  it  would  add  nothing  to  its  investment  upon 
which  it  would  be  allowed  to  earn  a  return.  It  would  be 
of  no  advantage  to  the  rate-payer,  because  it  would  add 
to  his  rates,  without  giving  him,  as  an  individual  (and 
he  must  be  considered,  in  this  connection,  only  in  his  in- 
dividual capacity),  anything  in  return  for  his  money; 
he  would  get  title  to  nothing  in  the  way  of  property,  and 
the  fact  that  future  rate-payers  might  benefit  from  the 
amounts  exacted  from  him  would  not  interest  him  in  the 
least. 

For  a  concrete  example,  consider  the  history  of  the 
average  gas  company:  It  is  organized,  capital  raised,  a 
plant  constructed,  the  latest  and  best  types  of  apparatus 
installed  therein,  and  mains,  services  and  meters  in- 
stalled on  the  district  to  be  served.  Do  the  projectors 
visualize  the  plant  and  equipment  in  which  their  capital 
is  invested  as  moving  relentlessly  towards  the  scrap-heap 
as  humanity  marches  from  the  cradle  to  the  grave  ?  Ver- 
ily they  do  not.  Do  they  construe  the  situation  as  de- 
manding that  they  begin,  at  once,  to  collect  from  their 
consumers,  in  the  rates,  over  and  above  the  cost  of  the 
service  and  a  fair  return  on  the  investment,  the  invest- 
ment itself  or  any  part  of  it?  Such  a  thing  was  never 
attempted  or  even  dreamed  of.  They  look  upon  the 
permanency  of  their  plant  and  equipment  as  second  to 
nothing  ever  created  by  mortal  hand.  They  know  that 
there  will  be  wear  and  tear  which  will  involve  repairs 
which,  as  they  are  made,  will  and  should  constitute  a  part 
of  the  current  cost  of  the  service.  They  know  that  such 
cost,  as  a  matter  of  practice,  is  not,  and  should  not  be, 
collected  in  advance,  for  the  obvious  reason  that  the 
earnings  for  each  year  should  bear  the  burden  of  the 
maintenance  expenditures  for  each  year,  otherwise  the 
statement  of  results  of  a  year's  operations,  in  so  far 


13 

as  the  revenue  and  expenses  are  concerned,  is  dis- 
torted; that  to  exact  from  rate-payers,  during  a  given 
year,  aa  amount  in  excess  of  the  expenditures  for  main- 
tenance for  such  year  is  ''robbing  Peter  to  pay  Paul,'* 
that  is,  if  the  amount  thus  exacted  is  used  to  pay  for 
future  maintenance  and  if  future  patrons  benefit  there- 
by; that  if  it  is  not  so  used,  such  an  exaction  results  in 
the  creation  and  maintenance  of  a  reserve  which  will 
be  forever  useless  for  the  purpose  of  making  replace- 
ments, which  is  the  purpose  for  which  it  was  alleged  to 
have  been  created ;  that  to  deal  with  maintenance  costs  as 
they  occur  is  to  deal  with  facts,  but  that  to  attempt  to 
anticipate  them  is  to  embark  upon  an  uncharted  sea  of 
idle  fancy  and  speculation.  They  take  no  heed  whatever 
of  future  obsolescence  or  inadeqaacy,  for  two  reasons: 
first,  because  not  being  clairvoyant,  they  cannot  foresee 
when,  if  ever,  obsolescence  or  inadequacy  in  respect  of  any 
unit  of  plant  or  equipment  is  going  to  occur,  and,  second, 
because,  being  business  men,  they  know  that  when,  if 
ever,  obsolescence  or  inadequacy  does  occur,  it  will  result 
from  an  advance  in  the  art  or  a  development  of  the  busi- 
ness which  should  and  will,  itself,  take  care  of  the  loss 
involved  in  the  displacement  of  the  retired  unit  of  plant 
or  equipment.  They  know,  therefore,  that  there  is  no 
economic  ground  upon  which  they  could  demand  from 
their  patrons  a  return  of  their  investment  or  any  part 
of  it.  They  know,  furthermore,  that  they  could  not  col- 
lect it  if  they  attenipted  to  do  so,  for  two  reasons :  first, 
that  the  public  would  object  to  paying  for  the  service  any 
amount  in  excess  of  the  cost  of  it  plus  a  fair  return  on 
the  investment  necessary  to  render  it ;  second,  because  an 
attempt  to  build  up  a  business  with  a  rate  thus  burdened 
with  a  purely  fictitious  and  uneconomic  charge,  would 
result  in  failure  and  bankruptcy. 

What  actually  occurs  may  be  described  as  follows : 
Assume  the  case  of  a  gas  company,  starting  business 
in  a  small  and  growing  municipality. 


14 

It  has  been  organized  in  response  to  an  urgent  de- 
mand on  the  part  of  the  community  for  a  supply  of  gas 
for  illuminating,  domestic  and  commercial  purposes. 

Its  organizers  are  citizens  having  some  money  to  in- 
vest and  some  credit. 

The  territory  is  canvassed  and  as  many  contracts  for 
service  are  made  as  can  be  obtained. 

A  franchise  is  obtained,  a  consulting  engineer  is 
called  in,  and  estimates  are  made  of  the  probable  present 
consumption  and  what  may  be  reasonably  expected  in 
the  way  of  annual  increases  therein. 

A  price  is  fixed  which,  it  is  estimated,  will  ultimately 
yield  a  return  upon  the  necessary  investment.  The  in- 
vestment in  land  and  manufacturing  plant  is  of  necessity 
based  upon  aii  estimated  future  demand  substantially 
greater  than  that  which  can  be  expected  to  be  realized  at 
the  outset. 

A  distributing  system  is  installed,  which  covers  the 
more  densely  populated  section  of  the  municipality. 

The  business  of  supplying  gas  is  begun  under  condi- 
tions which  make  it  impossible  for  the  company  to  re- 
cover all  of  its  operating  expenses. 

Then  comes  a  period  of  discouragement.  The  com- 
pany is  in  financial  stress.  All  the  anticipated  business 
may  not  have  been  realized  (it  seldom  is).  A  receiver- 
ship is  discussed.  Temporary  loans,  to  meet  payrolls 
and  bills  for  materials  and  supplies,  obtained  from  those 
who  have  already  sunk  capital  in  the  enterprise,  tide  the 
company  over  this  critical  period  of  its  career. 

By  vigorous  canvassing  and  judicious  extensions,  the 
utilization  of  the  property  is  increased,  so  that  the  gross 
revenues  exceed  the  operating  expenses  and  leave  a  bal- 
ance toward  over-due  fixed  charges. 

The  plant  and  distributing  system  being  new,  the 
maintenance  charges  are  comparatively  negligible. 

As  business  grows  without  proportionate  additional 
investment  of  capital,  net  earnings  increase;  likewise 


15 

the  cost  of  maintenance  through  repairs  and  replace- 
ments begins  to  be  a  factor  in  the  cost  of  operation. 

By  the  time  the  company  is  fairly  on  its  feet  and  is 
able  to  pay  a  return  upon  the  money  invested  in  it,  the 
cost  of  maintaining  the  property  by  repairs  and  renewals 
has  become  normal.  In  other  words,  it  has  reached  an 
average  annual  relationship  to  the  company's  gross  earn- 
ings, and  such  relationship  thereafter  will  vary  but 
slightly.  That  is  to  say,  a  sum  representing  a  given  per- 
centage of  the  gross  earnings  (which  may  be  expressed  in 
terms  per  thousand  cubic  feet  of  gas  sold)  will  suffice  to 
keep  the  property  in  a  high  state  of  service  efficiency. 

The  foregoing  is  what  happens  in  actual  practice  and 
is  a  true  picture  of  the  early  history  of  practically  every 
utility. 

Had  the  company  undertaken  at  the  outset  to  collect 
from  the  public  a  rate  which  would  have  included  a  re- 
turn to  it  of  half,  or  any  part,  of  its  capital  within  a 
given  number  of  years,  it  would  have  gone  bankrupt, 
unless  its  patrons,  aware  of  its  intention  so  to  do,  en- 
joined it  from  charging  a  rate  for  its  service  which  in- 
cluded such  return  or  repayment  of  its  capital. 

It  is  impossible  to  imagine  a  utility  so  situated  at- 
tempting to  collect  from  its  patrons,  during  a  period 
when  it  was  struggling  for  existence,  a  useless  reserve 
which  could  be  construed,  upon  final  analysis,  as  nothing 
else  than  a  return  to  it  of  a  part  of  its  investment,  or 
that  it  would  be  permitted  to  do  such  a  thing.  And  if, 
up  to  the  time  it  had  gotten  upon  its  feet  and  was  meet- 
ing, out  of  its  gross  earnings,  all  of  its  current  require- 
ments for  the  maintenance  and  upkeep  of  its  property, 
it  had  collected  no  such  reserve,  what  excuse  would  exist 
thereafter  for  its  undertaking  to  do  so? 

Thereafter,  normal  and  reasonable  rates  for  gas  will 
be  such  as  to  enable  it  to  meet  its  operating  expenses, 
to  maintain  its  property  by  renewals  and  replacements 
when  necessary,  and  to  earn  a  fair  return  upon  its  invest- 


16 

ment.  Such  being  the  case,  the  accumulation  of  a  reserve 
would  involve  an  unreasonable  increase  in  its  rates. 

Does  any  one  imagine  that  it  would  be  permitted, 
much  less  ordered,  to  increase  its  rates  for  the  purpose 
of  creating  a  useless  reserve  ?  If  nothing  may  be  properly 
collected  for  that  purpose,  then  it  is  obvious  that  no 
deduction  may  properly  be  made  from  its  investment; 
in  other  words,  no  depreciation  exists  in  respect  of  its 
property. 

Investors,  as  a  class,  engage  in  public  service  enter- 
prises because  they  deem  them  to  be  not  only  profitable 
but  permanent.  Money  put  into  railroad  construction, 
for  example,  can  never  be  withdrawn.  To  unmake  a  rail- 
road would  restore  no  amount  of  cash  to  those  who  con- 
structed it.  It  would  require  the  expenditure  of  almost 
as  much  money  in  the  unmaking  as  in  the  making — if  not 
more.  The  same  is  true  of  gas-mains,  electric-conduits 
and  all  sub-surface  structures  required  in  the  distribu- 
tion of  gas,  electric,  telephone,  telegraph,  steam  and 
water  service.  It  would  not  pay  to  dig  them  up.  Simi- 
larly, there  can  be  no  recovery  of  money  invested  in 
plant  and  equipment.  There  is  no  considerable  market 
for  second-hand  plant  and  equipment.  Therefore,  were 
it  not  for  the  permanent  character  of  the  public  service 
business  there  would  be  no  public  service,  because  no 
investor  would  embark  in  it  as  a  business.  Assured,  as 
he  has  every  reason  to  be,  of  the  permanence  of  the 
business,  he  looks,  with  equal  reason,  for  a  fair  return 
on  his  investment.  In  other  words,  he  expects  to  col- 
lect enough  for  his  service,  in  excess  of  the  cost  of  ren- 
dering it,  to  cover  not  only  bare  interest  on  the  amount 
of  his  investment  but  a  reasonable  margin  of  profit 
besides.  The  cost  of  rendering  the  service  includes,  of 
course,  the  cost  of  maintaining  his  plant  and  equipment 
in  efficient  operating  condition  by  repairs  and  renewals, 
as  well  as  the  cost  of  amortizing  the  investment  in  plant 
and  equipment  displaced  from  time  to  time  in  order  to 
effect  improvements  and  economies  made  possible  by 


17 

the  advance  in  the  art  of  rendering  the  particular  service 
in  which  he  is  engaged.  In  the  exercise  of  his  right  to 
earn  a  fair  return  upon  his  investment,  he  is  entitled  to 
and  should  receive  the  protection  of  the  courts. 

The  amount  which  he  collects  in  excess  of  the  cost  of 
rendering  the  service,  is  his  profit,  to  be  disposed  of  as 
he  may  see  fit.  That  is  to  say,  he  may  pay  it  out  in  divi- 
dends or  carry  it  in  a  surplus  account  or  segregate  it 
and  carry  it  in  a  reserve  account,  or  he  may  do  all  three 
of  these  things.  The  profits  which  he  does  not  take  out 
in  the  shape  of  dividends  he  may  employ  in  the  acquisi- 
tion of  additional  plant  and  property;  and  when  thus 
employed,  they  become  an  investment  of  his  in  the  same 
degree  precisely  as  does  the  cash  represented  by  the  com- 
pany's outstanding  capital  stock  and  obligations.  He 
expects  to  have  this  investment  maintained,  without  im- 
pairment, out  of  the  rates  which  he  collects  for  his 
service. 

The  rates  which  an  investor  charges  for  his  services 
include  nothing  which  may  be  construed  either  as  a  return 
to  him  of  any  of  his  investment  or  as  a  sum  advanced 
to  him  by  his  patrons  to  be  invested  by  him  for  their 
account  in  plant  and  property.  No  investor  has  ever 
been  a  party  to  such  an  understanding;  and  it  cannot, 
therefore,  be  assumed  that,  without  his  knowledge  or 
consent,  amounts  were  included  in  his  rates  for  either 
of  the  purposes  named.  The  reasons  for  this  are  ob- 
vious and  will  be  elaborated  later. 

On  the  other  hand,  the  point  of  view  of  the  public — 
that  is  to  say,  the  patron  of  the  investor — is  as  simple 
as  the  point  of  view  of  the  investor.  He  is  a  buyer  of 
service.  He  pays  for  it  a  price  which  he  understands 
represents  two  things,  first,  the  cost  of  rendering  the 
service,  including  the  repairs  and  renewals  of  the  plant 
and  equipment  employed  in  rendering  the  service,  and, 
second,  a  profit  to  the  investor.  So  long  as  that  profit  is 
fair  and  reasonable,  i.  e.,  equal  to  a  fair  and  reasonable 
return  on  the  investment,  he  is  not  interested  in  the 


18 

disposition  that  is  made  of  it;  that  is  to  say,  he  is  not 
interested  in  whether  it  is  all  paid  out  in  dividends,  or 
whether  part  is  paid  out  in  dividends  and  part  set  aside  in 
surplus  and  reserve  accounts  and  invested  in  additional 
plant  and  equipment.  He  knows  that  an  investment  of  un- 
divided profits  in  plant  and  equipment  is  in  the  nature  of 
a  short  cut  amounting  to  the  same  thing  as  a  payment 
of  all  the  profits  in  dividends  and  a  re-investment  involv- 
ing an  issue  of  securities  and  that  the  difference  between 
these  two  methods  is  one  of  form  and  not  of  substance. 
He  does  not  consider  that  there  is  included  in  the  rate  he 
pays  for  the  service  he  receives  any  amount  representing 

(a)  a  return  to  the  investor  of  a  part  of  his  investment  or 

(b)  an  investment  on  his  own  part  in  some  of  the  prop- 
erty employed  in  rendering  the  service  which  he  receives. 
Being  satisfied  that  the  rate  which  he  pays  covers  the 
two  items  heretofore  enumerated,  viz:  the  cost  of  the 
service  and  a  reasonable  profit  to  the  investor,  he  would 
not  consent  (if  he  were  consulted)  to  have  such  rate 
increased  in  order  that  there  might  be  included  therein 
an  amount  designed  for  either  of  the  other  purposes 
named.  Therefore,  there  is  no  ground  on  which  to  base 
an  assumption  that,  without  his  knowledge  and  without 
any  intent  on  his  part,  there  was  ever  included  in  the 
rates  which  he  paid  for  the  service  he  received  any 
amount  in  addition  to  the  cost  of  the  service  and  a  fair 
profit  to  the  investor. 

Notwithstanding  the  manifest  absence  of  any  knowl- 
edge or  intent,  on  the  part  of  the  investor  or  his  patron, 
to  engage  at  any  time  in  any  such  preposterous  trans- 
action as  is  alleged  to  have  been  in  effect,  we  have  never- 
theless in  this  so-called  ** depreciation  theory,"  a  theory 
by  which  its  advocates  attempt  to  establish  a  division 
of  the  property  operated  by  a  utility  between  that  which 
is  owned  by  the  company  and  that  which  is  owned  by 
the  public.  According  to  these  professional  depre- 
ciators,  the  company  may  earn  a  return  upon  so  much 
of  the  property  as  the  depredators  are  willing  to  con- 


19 

cede  belongs  to  the  company;  but  upon  that  portion  of 
it  which  they  allege  belongs  to  the  public,  no  return  may 
be  earned.  It  is  to  be  hoped,  however,  that  we  have  not 
yet  reached  the  stage,  in  this  country,  where  title  to 
property  may  be  disputed  upon  so  flimsy  a  pretext. 

Even  if  it  were  deemed  advisable  that  henceforth,  as 
a  matter  of  policy,  an  investment  should  be  made  by  the 
public  in  properties  operated  by  utilities,  through  the 
medium  of  the  rates  charged  for  the  service,  it  is  difficult 
to  conceive  how  such  a  policy  could  be  made  effective. 
It  would  be  necessary,  for  example,  that  the  policy  should 
become  universal.  It  would  then  be  necessary  to  ascer- 
tain by  inventory  and  appraisal  the  value  of  the  property 
of  every  utility  in  the  country.  Eates  for  service  would 
have  to  be  increased  universally,  so  that  there  might  be 
included  therein  a  percentage  designed  to  apply  either 
toward  the  purchase  of  existing  plant  and  property  or 
toward  the  purchase  of  plant  and  property  to  be  acquired 
thereafter.  Thereafter,  the  amount  thus  invested  might 
be  known;  but  how  about  the  property  in  which  invest- 
ment has  already  been  made  ? 

In  view  of  the  fact  that  all  plants  would  be  acquired 
by  utilities  in  their  own  names,  how  would  the  title  there- 
to become  vested  in  the  public?  The  rate-payers  of  yes- 
terday are  not  the  rate-payers  of  today  and  the  rate- 
payers of  today  are  not  the  rate-payers  of  tomorrow. 
Why  should  the  rate-payer  of  today  pay  for  something 
which  is  to  be  owned  by  the  rate-payer  of  tomorrow? 
In  which  of  the  various  classes  of  property  required  by 
a  utility  would  the  public  prefer  to  have  its  investment 
made,  and  for  which  class  of  property  would  the  utility 
itself  have  a  preference?  It  is  but  necessary  to  consider 
these  few  questions  to  establish  the  absurdity  of  the 
whole  proposition. 

Furthermore,  there  is  not  the  remotest  possibility  that 
the  public,  if  fully  informed,  would  lend  its  approval  to 
such  a  hare-brained  proposition. 


20 

The  effect  of  the  propaganda  of  the  professional  depre- 
dators and  of  the  decisions  of  some  courts  and  commis- 
sions which  have  appeared  to  sustain  it,  have  been  to 
render  investors  uneasy. 

Those  who  are  already  in  are  not  going  in  any  deeper, 
and  those  who  are  not  in  will  stay  out  until  this  propa- 
ganda has  had  its  final  quietus.  This  attitude  on  the 
part  of  investors  is  a  distinct  and  palpable  public  dis- 
advantage. Confidence  in  the  stability  of  their  invest- 
ments is  indispensable  to  the  ready  flow  of  capital  to 
meet  the  public  demand  for  increased  and  improved 
service  and  for  the  development  of  vast  territories  at 
present  without  railroads,  gas,  electric,  telephone  or 
telegraph  service.  Is  it  not  the  time  to  call  a  halt  on 
the  activities  of  men  whose  principal  aiin  in  life  appears 
to  be  to  impair  the  investments  in  properties  devoted 
to  the  public  service  and  whose  usefulness  is  on  a  par 
with  that  of  the  Russian  Bolsheviki? 

The  so-called  ** depreciation  theory"  begins  with 
imaginary  premises,  progresses  through  academic  maun- 
derings  and  emerges  as  pure  nonsense.  It  has  not  a 
leg  to  stand  on  in  public  policy,  economics,  finance  or 
common  sense.  Nevertheless,  so  plausibly  has  it  been 
presented  and  so  active  has  been  the  propaganda  in  its 
behalf  that  some  courts  and  commissions  have  accepted 
it  as  the  law  and  gospel  of  utility  valuation.  It  has 
even  been  accepted  and  availed  of  by  some  public  service 
companies,  the  result,  it  must  be  assumed,  of  a  super- 
ficial consideration  of  the  whole  subject  of  plant  main- 
tenance and  upkeep.  Some  members  of  the  engineering 
fraternity  who  by  training  or  study  are  neither  econo- 
mists nor  financiers  but  who  have  been  impressed  with 
the  magnificent  vocabulary  of  this  new  pseudo-science, 
have  swallowed  the  bolus  whole.  Other  engineers  who 
have  studied  the  questions  and  who  have  not  been  im- 
pressed  by  the  claims  made  for  this  new  elixir  of  life, 
have  rejected  it  altogether.    One  State  Commission  has 


•21 

already  reversed  itself  in  this  regard  and  has  eliminated 
from  its  accounting  system  any  recognition  of  the  theory. 

An  inspection  of  the  plant  and  equipment  of  an  operat- 
ing company,  at  any  time,  would  disclose  nothing  more 
respecting  the  life  expectancy  of  the  units  thereof  than 
an  inspection  of  it  at  the  time  the  company  started  busi- 
ness. It  would  disclose,  however,  in  respect  of  the  wearing 
parts  of  such  plant  and  equipment,  including  such  small 
parts  as  rails,  ties,  poles,  gas  and  electric  meters,  etc., 
that  at  some  time,  more  or  less  remote,  as  the  case  might 
be,  repairs  and  replacements  would  have  to  be  made  to 
make  good  wear  and  tear.  But  just  as  the  current  in- 
come is  taking  care  of  similar  current  repairs  and  re- 
placements, the  future  income  will  take  care  of  future  re- 
pairs and  replacements,  as  they  become  necessary.  To  at- 
tempt to  keep  plant  and  equipment  always  in  a  condition 
as  good  as  new  would  be  wasteful  and  extravagant.  It 
would  add  immeasurably  to  the  cost  of  the  service  without 
producing  any  compensating  advantages  to  the  rate- 
payer. In  other  words,  the  service  condition  of  a  plant 
and  equipment  may  be  as  good  as  new  without  the  plant 
itself  being  in  a  condition  as  good  as  new.  It  adds  noth- 
ing, for  example,  to  the  serviceability  of  a  structure  to 
paint  it  more  often  than  is  economically  necessary.  It 
adds  nothing  to  the  serviceability  of  a  machine  to  replace 
a  wearing  part  that  is  still  giving  as  good  service  as  a 
new  part  would  give„ 

At  any  time,  an  engineer  may  discount — ^not  accurately 
but  approximately — the  ultimate  cost  of  the  repairs  and 
replacements  of  working  parts,  including  small  units, 
which  a  physical  inspection  of  a  plant  and  equipment 
discloses  will  have  to  be  made  in  the  near  or  remote 
future.  He  may  estimate  the  cost  of  replacing  a  rail, 
he  may  make  a  more  or  less  wild  guess  as  to  the  date 
when  it  will  have  to  be  replaced,  he  may  adopt  some 
rate  of  interest;  and  with  these  three  factors  and  an 
interest  table,  he  may  determine  the  present  sum  of 
money  which,  at  the  given  rate  of  interest,  wiU  be  the 


22 

amount  which  it  will  ultimately  cost  to  replace  the  rail. 
He  may  make  a  similar  computation  with  respect  to  a 
gas-meter  or  a  pole  supporting  electric  wires.  But  when 
he  has  done  so,  he  has  determined  nothing  as  to  the 
investment  in  the  property.  The  condition  of  the  par- 
ticular units  of  plant  and  equipment  on  which  he  bases 
his  computation  is  only  a  temporary  one.  It  is  a  mere 
incident  of  plant  and  equipment  operation.  It  possesses 
no  economic  significance  whatever.  As  the  sum  com- 
puted will  be  paid  out  of  the  rate  collected  from  the 
rate-payers,  as  repairs  and  replacements  mature,  it  may 
be  described  as  an  "unmatured  obligation"  of  the  rate- 
payers to  reimburse  the  company  for  maintenance  of  the 
plant  and  equipment,  through  the  medium  of  the  rates 
which  they  pay  for  the  service  they  receive.  There  is 
no  more  reason  for  collecting  such  expense  in  advance 
than  there  is  for  collecting  this  year  the  salaries  and 
wages  to  be  paid  two  or  three  years  hence;  and  as  a 
matter  of  business  practice,  it  is  never  done. 

The  fact  that,  as  a  matter  of  accounting  practice,  some 
companies  have  a  repair  suspense  account  or  a  renewal 
and  replacement  suspense  account  to  equalize  the  annual 
charges  against  the  earnings,  for  repairs  or  renewals, 
is,  of  course,  a  matter  of  no  consequence  whatever.  Such 
accounts  at  any  given  time  may  be  either  debit  or  credit 
accounts. 

Since  there  is  no  sound  basis  in  public  policy,  law, 
economics  or  finance  for  collecting,  in  advance  of  the 
necessity  for  using  the  money,  a  so-called  **  depreciation 
reserve,"  it  follows  that,  where  no  such  reserve  has  been 
created,  the  investment  remains  unimpaired.  It  may 
even  be  assumed,  in  cases  where,  under  a  mistaken  con- 
ception of  the  problem  of  plant  maintenance  or  under  the 
compulsion  of  commission  order,  a  **  depreciation  re- 
serve" has  been  created,  that  nevertheless  the  invest- 
ment remains  intact.  In  order  to  sustain  the  contrary, 
it  would  have  to  be  affirmatively  shown  that  the  reserve 
actually  constituted  a  return  directly  or  indirectly  of 


capital  to  the  investor  or  that  it  actually  represented  an 
investment  on  the  part  of  the  rate-payers,  with  their 
knowledge  and  consent  and  with  the  company's  knowl- 
edge and  consent,  in  plant  and  equipment  bought  by  the 
company,  paid  for  with  its  money  and  to  which  it  holds 
an  indisputable  vested  and  legal  title.  It  would  have 
to  be  shown  that  the  earnings,  during  the  period  the 
reserve  was  accumulating,  plus  the  reserve  itself,  con- 
stituted more  than  a  fair  return,  in  fact  an  exces- 
sive and  illegal  return,  on  the  actual  investment.  The 
mere  fact  that  the  reserve  was  created  through  operat- 
ing expenses  instead  of  through  income  account  is  not 
controlling.  Economic  facts  cannot  be  disturbed  by  the 
mere  incidence  of  bookkeeping.  Accountants  are  neither 
financiers  nor  economists.  Questions  of  property  rights 
cannot  be  determined  by  the  entries  they  make  in  their 
books.  In  other  words,  the  substance  of  the  question 
cannot  yield  to  the  form  which  the  accountant  has 
chanced  to  observe  in  making  his  book  entries.  If  by 
any  other  process  of  reasoning  the  investment  may  be 
concluded  to  have  become  impaired,  then  it  is  evident 
that  property,  which  may  not  yet  be  taken  by  the  direct 
action  of  the  syndicalists,  may  be  taken  indirectly  by 
ingenuous  sophistries. 

An  investor's  property  represents  his  investment  and 
is  in  fact  his  investment.  It  is  immaterial  that  on  the 
other  side  of  his  balance  sheet  his  investment  is  repre- 
sented by  given  amounts  of  capital  stock,  funded  and 
floating  debt  and  surplus  and  reserves.  The  aggre- 
gate of  these,  corresponding  with  the  aggregate  of  his 
assets,  indicate  his  hook  investment,  which  may  or  may 
not  be  his  actual  present  investment.  In  other  words, 
if  the  land  he  owns  has  substantially  enhanced  in  value, 
its  enhanced  value  measures  the  amount  of  his  invest- 
ment therein.  It  is  not  necessary  that  he  should  sell  it 
and  buy  it  again  and  credit  the  increment  in  value  to  his 
surplus  account  in  order  to  determine  his  actual  invest- 
ment.   The  courts  of  this  state  have  so  definitely  decided. 


24 

The  Supreme  Court  of  the  United  States  has  ruled  that 
the  present  value  is  the  controlling  consideration  in 
respect  of  all  property.  While  it  is  obvious  that  there 
is  no  economic  difference  between  the  land  and  plant 
to  which  an  investor  holds  title,  it  is  still  a  question  of 
policy  whether,  as  to  plant,  a  claim  should  be  set  up  for 
recognition  of  the  present  investment  therein,  when  pres- 
ent unit  costs  are  deemed  to  be  abnormal  and  temporary. 

The  question  really  hinges  on  whether  an  investor  in 
plant  and  equipment  devoted  to  the  public  service  is  in  a 
different  class  from  an  investor  in  real  estate,  merchan- 
dise or  salable  commodities,  in  that  he  may  not  realize  on 
the  increment  in  the  value  of  his  property,  by  being  al- 
lowed to  earn  a  return  upon  such  increment,  however  it 
may  have  been  created,  during  the  period  that  it  may  be 
shown  to  exist,  but  is  forever  confined  to  his  original 
investment  upon  which  he  is  entitled  to  earn  a  fair 
return ;  in  other  words,  whether  any  injustice  is  done  the 
user  of  the  service  if  the  rate  he  pays  at  any  given  time 
provides  a  fair  return  on  the  investment  in  the  property 
devoted  to  his  service,  measured  by  the  cost  of  repro- 
ducing the  plant  and  equipment  at  that  time. 

It  is  not  proposed  to  elaborate  upon  this  theme  here. 
SuflSce  it  to  say  that,  in  determining  a  reasonable  rate  or 
in  reviewing  an  established  or  prescribed  rate,  it  is  ob- 
viously the  function  of  the  court  or  commission  to  deter- 
mine the  investment  upon  which  a  fair  return  must  be 
permitted.  Whether  this  shall  be  the  original  invest- 
ment or  the  present  investment  is  for  the  court  to  deter- 
mine. In  either  event,  the  investment  must  be  deemed 
to  be  unimpaired. 

It  is  equally  obvious  that  it  is  the  function  of  the 
engineer  to  inform  the  mind  of  the  court  as  to  facts  and 
not  as  to  theories  of  economics  or  finance  or  rules  of 
law,  about  which  an  engineer,  as  an  engineer,  has  no 
expert  knowledge  or  experience.  The  facts,  as  to  which 
the  engineer  is  competent  to  testify  as  an  expert,  are 


25 

the  inventory  of  the  plant  and  the  original  and  present 
investment  therein. 

The  court  will  base  its  conclusion  as  to  which  invest- 
ment it  will  adopt  upon  the  circumstances  of  the  case. 
It  is  a  matter  for  argument  by  counsel. 

When  an  engineer,  testifying  in  a  rate  case,  expresses 
his  conclusions  as  to  the  extent  of  present  liability  to 
make  future  repairs  and  replacements  in  terms  of  dimin- 
ished value,  he  leaves  his  own  jurisdiction  to  wander 
in  that  of  the  economists.  Before  he  can  justify  any 
estimate  of  value,  he  must  know  what  value  is.  Is  the 
depreciated  value  to  which  he  testifies  market  value,  or 
exchange  value?  Is  it  value  estimated  by  considering 
what  each  depreciated  item  would  sell  for  alone,  or  what 
the  whole  plant  would  sell  for  altogether?  Or  is  his 
value  estimated  on  consideration  of  potential  utility  and, 
if  it  is  so  considered,  is  it  utility  to  the  owner  as  a  means 
of  making  money,  or  is  it  utility  to  the  community  served, 
measured  by  what  the  community  would  rather  pay  than 
lose  the  service  and  use  the  next  best  substitute?  Is 
there  such  a  thing  as  *'use  value"  and  such  another 
thing  as  "exchange  value,"  or  is  exchange  value,  either 
subjective  or  objective,  the  only  kind  of  value  there  is? 
Or  is  the  engineer  measuring  "value  for  rate  purposes" 
and,  if  he  is,  what  kind  of  value  is  it  that  is  "value  for 
rate  purposes?" 

^'SHiat  has  an  engineer  to  do  with  the  thousand  and  one 
theories  of  what  value  is,  and  how  shall  he  have  the 
hardihood  to  attempt  to  measure  it  before  he  knows 
what  it  is  that  he  is  measuring?  He  may  as  well  furnish 
charts  showing  average  lengths  of  the  beaks  and  tails 
of  hippogrif  s. 

Engineering  has  to  do  with  physical  facts  and  measure- 
ments of  physical  bodies.  It  concerns  itself  with  costs, 
both  past  and  present.  An  engineer  may  testify  as  to 
such  costs ;  but  when  he  testifies  that  the  value  of  plant 
and  equipment  has  decreased  in  some  specified  amount 
or  percentage,  either  because  of  assumed  expiration  of 


26 

life  of  the  units  of  which  the  plant  is  composed,  or  be- 
cause maintenance,  presently  unmatured  will,  later  on, 
make  it  necessary  to  expend  money,  he  is  usurping  the 
functions  of  economists  and  courts.  He  is  following 
some  academic  ''method,"  without  being  able  or  com- 
petent to  explain  why  "half  life  half  value"  or  similar 
phrases,  have  more  significance  than  the  linguistic  efforts 
of  a  parrot. 

On  the  other  hand,  an  engineer  may  testify  to  the 
amount  of  the  investment,  either  the  original  or  present 
investment.  If  the  books  do  not  show  it,  he  may  esti- 
mate it  approximately.  That  is  his  true  function.  He 
may  estimate  the  probable  original  cost  or  the  probable 
cost  of  reproduction  at  present  prices.  He  may  express 
the  total  as  value,  if  he  makes  it  clear  that  by  value 
he  means  costs,  computed  on  one  basis  or  another;  but, 
having  made  such  an  estimate  of  value,  on  the  basis  that 
value  means  investment,  he  cannot  properly  reduce  it 
after  shifting  to  the  theory  that  value  means  ''what  a 
thing  will  sell  for,"  or  that  it  decreases  proportionately 
with  a  diminished  store  of  potential  utility.  That  is 
precisely  what  he  does  when  he  blithely  converts  "con- 
dition per  cent.,"  into  dollars  and  cents  under  the  head- 
ing "present  value." 

The  investment  stated  by  the  engineer  should  not  in 
all  cases  purport  to  be  the  amount  of  the  entire  invest- 
ment which  is  to  be  considered  in  a  rate  case.  The  New 
York  Court  of  Appeals  has  ruled,  in  the  Kings  County 
Lighting  Company  case  (210  N.  Y.  479),  "wholly  apart 
from  the  intangible  thing  called  going  business,  the 
reproductive  value  today  of  the  physical  property  would 
not  necessarily  include  the  actual  and  legitimate  invest- 
ment in  tangible  property  which  may  have  been  entirely 
replaced,  not  because  of  depreciation,  but  to  meet  ad- 
vances in  mechanical  science,  new  conditions  and  increas- 
ing demands  not  reasonably  to  have  been  foreseen  at  the 
start.  *  *  •  In  some  manner  and  under  some  head- 
ing a  due  allowance  must  be  made  for  the  investment 


27 

in  those  elements."  The  engineer,  if  requested,  may 
properly  testify  as  to  the  amount  of  such  investment, 
on  the  basis  of  cost  of  construction;  but  the  matter  of 
adding  such  amounts  to  his  estimate  of  the  investment 
value  of  property  presently  in  use,  or  of  disregarding 
such  amounts,  is  dependent  upon  other  questions.  Has 
the  amount  of  such  investment  been  wholly  or  partly 
amortized  by  the  rates?  This  is  a  question  of  account- 
ing. Should  any  amount  not  so  amortized  be  added  to 
the  rate  base?    That  is  a  matter  of  law. 

It  is  not  too  much  to  say  that  conclusions  of  engineering 
experts  have  been  accepted  by  courts  and  commissions 
as  based  on  facts  wholly  within  the  scope  of  engineering 
science,  whereas  they  are  partly  founded  on  opinions 
as  to  economics,  accountancy  and  law,  although  the  whole 
basis  of  opinion  has  not  been  perceived  either  by  the 
courts  or  by  engineers  themselves,  and  that  no  incon- 
eiderable  part  of  the  difficulties  with  which  public  utili- 
ties have  been  struggling  have  their  origin  in  the  ready 
acceptance  by  courts  and  commissions  of  the  opinion  of 
engineers  as  to  matters  in  which  they,  as  a  rule,  are  not 
qualified  to  testify  as  experts. 

It  is  obvious  that  this  subject  is  one  which  concerns 
and  should  engage  the  serious  attention  of  every  investor 
in  public  utility  securities.  It  cannot  be  assumed,  for  it 
is  not  true,  that  the  matter  is  receiving  the  attention  it 
should  from  those  whom  investors  have  intrusted  with 
the  protection  of  their  interests.  Bankers,  attorneys, 
engineers  and  accountants  have,  as  a  rule,  given  it  but 
scant  consideration.  Many  have  accepted  the  utterances 
of  doctrinaries  as  the  last  word  on  the  subject.  Account- 
ing rules  prescribed  by  Commissions,  which  are  based 
upon  the  acceptance  of  false  theories,  have  been  regarded 
as  controlling  when  they  are  not. 

It  is  *'up  to  you,"  therefore,  Mr.  Investor,  to  see  that, 
in  respect  of  your  particular  investments,  you  are  re- 
ceiving adequate  protection.  Do  not  wait  until  your  com- 
pany is  confronted  with  a  rate  case  to  discover  that  with- 


28 

out"  your  knowledge  or  consent  a  condition  of  affairs  has 
been  established  in  the  accounts  of  your  company, 
through  the  acceptance  of  false  doctrines  and  economic 
theories,  which  jeopardizes  your  interests  and  adds  im- 
measurably to  the  task  of  protecting  your  property  from 
confiscation.  If  an  action  is  brought  against  your  com- 
pany to  reduce  its  rates,  see  that  only  such  lawyers, 
engineers  and  financial  experts  are  engaged  to  defend  it 
as  have  studied  this  subject  and  are  familiar  with  every 
phase  of  it  and  are  prepared  and  qualified  to  protect  their 
clients'  interests. 

It  was  not  the  intention  of  the  writer  to  cite  any  opin- 
ions, either  of  courts,  commissions,  economists  or  en- 
gineers, sustaining  the  views  herein  expressed.  There  is 
one  case,  however,  that  of  the  Pocatello  (Idaho)  Water 
Company,  which  so  well  illustrates  the  application  of 
sound  economics,  sound  law  and  sound  common  sense 
that  he  ventures  to  subjoin  an  extract  from  the  opinion 
of  Public  Utility  Commissioner  Ramstedt,  which  was 
practically  sustained  by  the  Court,  the  opinion  of  the 
majority  having  been  overruled;  an  extract  from  the 
opinion  of  the  Court  in  that  case,  in  which  it  was  finally 
decided  that  so-called  ''accrued  depreciation"  should  not 
be  deducted  from  the  value  of  the  properties  of  public 
utilities;  and  an  editorial  comment  on  the  case  which 
appeared  in  the  New  York  Commercial.  It  may  be 
assumed,  in  respect  of  the  first  sentence  of  his  opinion, 
that  Commissioner  Ramstedt  would  qualify  it  in  respect 
of  such  units  as  are  only  displaced  because  of  obsolescence 
or  inadequacy,  and  which,  being  composed  of  stone,  con- 
crete, iron  and  steel,  would  last  as  long  as  the  walls  of 
Carcassonne.  Stephenson's  second  locomotive  was  still 
in  use  in  1911  (''Engineering  and  Contracting,"  October 
11,  1911).  The  cast-iron  water-pipes  leading  from  the 
river  Seine  to  the  fountains  at  Versailles,  were  installed 
in  1658.  The  only  repairs  that  have  been  necessary  after 
two  and  a  half  centuries  of  service  is  the  occasional  re- 
placing of  bolts  ("Engineering  and  Contracting,"  May 


29 

27,  1914).  Rome  is  still  supplied  with  water  by  an  aque- 
duct the  construction  of  which  was  begun  by  Quintus 
Marcius  in  144  B.  C.  Tunis  is  now  supplied  by  an  aque- 
duct built  by  Hadrian  in  A.  D.  120.  The  aqueduct  at 
Nimes  has  been  in  use  for  nearly  twenty  centuries.  There 
are  many  other  instances  of  masonry  and  concrete  struc- 
tures which  have  survived  many  hundreds  of  years  of 
useful  service. 

The  italics  are  ours. 

Extract  from  Commissioner  Ramstedt's  opinion: 

"Physical  depreciation,  resulting  from  use,  decay 
and  the  action  of  the  elements,  is  a  constant  factor 
commencing  simultaneously  with  construction  and 
ending  with  replacement.  A  person,  having  invested 
his  money  in  a  continuous  business  enterprise  for  the 
benefit  of  others,  as  in  the  case  of  the  petitioner 
herein,  and  in  so  doing  having  subjected  his  property 
to  the  control  of  the  state,  from  which  control  it  can- 
not be  withdrawn,  must  always  be  ready  and  able  to 
meet  the  public  demand  and  to  replace  the  construct- 
ive portions  of  his  plant  from  time  to  time  as  they 
wear  out  and  decay.  A  person  having  embarked  on 
such  an  enterprise  is  justly  entitled  to  compensation 
to  cover  this  depreciation  in  addition  to  a  fair  return, 
over  and  above  expenses,  upon  the  reasonable  value 
of  the  property  which  he  has  employed  for  public  use, 
for  the  same  reason  that  a  laborer  using  his  tools  is 
entitled  to  wages  which  will  not  only  compensate  him 
for  his  services,  but  enable  him  to  replace  his  tools  as 
they  wear  out.  Allowance  for  depreciation  cannot, 
in  my  judgment,  be  considered  as  profit  or  an  earning 
factor  in  the  business.  The  expenditure  necessary  to 
make  replacements  at  any  time  may  exceed  the 
amount  received  up  to  that  time  to  cover  the  cost  of 
such  replacements;  on  the  other  hand,  the  cost  of 
making  replacements,  at  a  certain  time  may  be  very 
much  less  than  the  amount  received  up  to  that  time 
to  cover  depreciation.  The  theory  of  allowance  to 
cover  depreciation  must  be  that  in  the  long  run  the 
owner  will  be  reimbursed  for  the  money  which  he 
must  spend  in  making  replacements,  which  in  the 


30 

very  nature  of  his  business  he  must  make  from  time 
to  time.  The  fact  that  the  amount  he  has  received 
from  the  public  at  any  time  is  either  greater  or  less 
than  the  amount  which  he  has  expended  for  replace- 
ments, if  the  allowance  for  depreciation  is  correctly 
computed,  does  not  affect  the  returns  to  which  he  is 
justly  entitled  on  his  original  investment.  He  is 
entitled  to  a  fair  return  on  his  investment  and  to 
hold  the  undepreciated  property,  or  its  equivalent  in 
value,  which  he  has  employed  for  public  use. 

''The  fact  that  in  an  investigation  of  the  peti- 
tioner's property,  undertaken  at  this  particular  time, 
for  the  purpose  of  fixing  rates,  it  is  found  that  the 
market  value  of  his  physical  property  employed  for 
public  use  has  depreciated  $77,188.39,  does  not,  in  my 
judgment,  justify  the  Commission,  in  its  determina- 
tion of  a  fair  value  for  rate  purposes,  to  deduct  the 
amount  of  depreciation  from  the  present  estimated 
cost  of  reproducing  the  property  now,  and  thereby 
reduce  the  earning  power  of  his  property.  The  peti- 
tioner has  undoubtedly  in  the  past  twenty  years  made 
such  replacements  from  time  to  time  as  the  public 
service  demanded,  and  must  at  all  times  be  prepared 
to  make  such  replacements  as  the  public  service 
justly  demands.  The  depreciation  which  we  now  find 
in  the  physical  value  of  the  property  is  somewhat  in 
the  nature  of  incumbrance  which  must  be  taken  care 
of  sooner  or  later  and  without  increase  in  rates  by 
reason  thereof;  in  fact,  a  large  portion  of  the  im- 
provements which  under  the  order  of  the  Commis- 
sion, he  is  required  to  make  within  the  year  is  really 
replacements,  and  I  cannot  see  how  we  can  justly 
decrease  the  earning  power  of  his  property  by  de- 
creasing the  investment  on  which  he  may  earn  a  fair 
return.  Whenever  the  time  comes  when  any  great 
amount  of  replacement  is  necessary,  and  that  may  be 
at  any  time,  he  may  be  required  to  expend  all  that  he 
has  ever  received  to  cover  depreciation  and  a  good 
portion  of  his  earnings. ' ' 

Extract  from  the  Court's  opinion: 

"So  far  as  the  question  of  depreciation  is  con- 
cerned, we  think  deduction  should  be  made  only  for 
actual,  tangible  depreciation,  and  not  for  theoretical 


31 

depreciation,  sometimes  called  'accrued  deprecia- 
tion. '  In  other  words,  if  it  be  demonstrated  that  the 
plant  is  in  good  operating  condition  and  giving  as 
good  service  as  a  new  plant,  then,  the  question  of 
depreciation  may  be  entirely  disregarded." 

Editorial  from  New  York  Commercial: 

"Rate-making  is  based  on  the  costs  of  operation 
and  maintenance  and  on  the  money  invested  in  the 
plant,  no  matter  what  may  be  the  nature  of  the  ser- 
vice rendered  to  the  public.  It  is  usually  easy  to 
estimate  current  expenses  and  income.  The  sticking 
point  is  almost  always  the  valuation  of  the  plant  of 
any  public  utility.  Its  original  cost  may  be  proved 
beyond  dispute  but  the  allowance  for  depreciation  is 
always  a  bone  of  contention. 

"Why  should  a  private  corporation  be  asked  or 
forced  to  forego  returns  on  money  actually  invested 
because  some  years  have  elapsed?  If  a  municipality 
constructs  a  water  system  the  ratepayers  bear  the 
cost.  If  mistakes  were  made  at  the  beginning  the 
bonds  issued  must  be  paid  at  maturity  no  matter  how 
the  money  was  spent.  Every  great  public  work  is 
liable  to  contain  some  defect  which  must  be  replaced. 
Human  skill  has  never  prevented  all  mistakes.  The 
engineers  who  dug  the  Panama  Canal  have  been 
powerless  to  stop  the  slides  in  the  Culebra  Cut  and 
dredging  them  out  will  add  to  the  cost  of  the  Panama 
Canal  unknown  millions  of  dollars.  If  inventors  and 
engineers  did  not  experiment  we  would  make  little 
progress,  and  money  so  spent  is  not  wasted  though  it 
yield  no  direct  profits. 

"When  a  public  utility  company  scraps  old  equip- 
ment and  installs  improved  machinery  it  serves  the 
public  and  should  receive  a  fair  return  on  all  it  spends 
in  this  way.  Physical  depreciation  is  a  constant  fac- 
tor and  is  balanced  by  repairs  and  replacements. 
The  Supreme  Court  of  Idaho  has  reversed  an  order 
of  the  Public  Utilities  Commission  of  that  state  by 
disallowing  a  deductions  from  the  value  of  a  water 
company's  property  of  so-called  'accrued  deprecia- 
tion* which  was  theoretical  and  not  actual,  the  plant 
being  in  condition  to  give  as  good  service  as  when 
first  constructed.   The  Court  found  that  the  company 


32 

made  snch  replacements  as  were  necessary  to  serve 
the  public  and  that  an  arbitrary  decrease  in  the  in- 
vestment on  which  it  was  entitled  to  a  fair  return 
was  unjustified.  The  sum  involved  was  $77,000,  the 
deduction  of  which  would  he  equivalent  to  confisca- 
tion without  recompense.  This  case  upholds  the 
right  of  investors  to  receive  a  return  on  money  prop- 
erly expended  in  the  first  place." 


(Qll73Bl0)476-A-3a 


r^onei  al  Library    . 


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1*^ 


,  „.,V-100m 


.7,'39(402s) 


494105 


UNIVERSITY  OF  CALIFORKJA  LIBRARY 


